Carbon capture and sequestration ("CCS") is a leading option for reducing greenhouse gas emissions. Until recently, CCS has been cost-prohibitive in the United States, and has lacked a regulatory mandate that would stimulate development. However, the potential of CCS may now be moving closer to realization as a result of developing tax and regulatory incentives. This update addresses current issues related to incentives for the capture and sequestration of carbon dioxide ("CO2
") with the availability of both federal tax credits ("Section 45Q") and regulatory credits under California's Low Carbon Fuel Standard ("LCFS"). As discussed below, the accelerating level of incentives for CCS projects may provide new business opportunities for project sponsors, investors, contractors and other market participants.
Section 45Q Tax Credits
Internal Revenue Code Section 45Q provides a tax credit for the sequestration or use of qualified carbon oxides (“COx
”), including CO2
. Although Section 45Q was enacted in 2008, there was uncertainty about the number of available credits that inhibited its use.
Under amendments incorporated into the Bipartisan Budget Act of 2018 (the “BBA”), enacted February 9, 2018, eligibility for the credit was expanded, the value of the credit was increased, and the cap was removed.
The BBA expanded the qualifications for using the credit to include:
- Projects for which construction commences prior to January 1, 2024;
- Volumes of COx sequestered during the 12-year period after qualifying carbon capture equipment is placed in service and qualified COx is disposed of in secure geologic storage; and
- Direct air capture projects.
The BBA also increased the value of the credits, which are now calculated as follows:
Comments Requested by the IRS
- Enhanced Oil and Gas Recovery: For COx that is sequestered in connection with enhanced oil or gas recovery, the credit starts at $12.83 per metric ton (“MT”) in 2017 and increases to $35/MT by 2026. From 2027 onward, the value of the credit associated with sequestration associated with enhanced oil or natural gas recovery will be $35/MT, adjusted for inflation.
- Other Sequestration: For COx that is sequestered but not used in connection with enhanced oil or gas recovery, the credit starts at $22.66/MT in 2017 and increases to $50/MT in 2026. From 2027 onward, the value of the credit associated with sequestration of COx (not associated with enhanced oil or natural gas recovery) will be $50/MT, adjusted for inflation.
. In Notice 2019-32, the Internal Revenue Service (“IRS”) solicited public comments in connection with the issuance of guidance on interpretive questions associated with the Section 45Q tax credit. The IRS requested comments–which are due on July 4, 2019
–on such key issues as the measurement of COx
that is used or sequestered, the methods for ensuring that such sequestered COx
remains securely stored, and the methods by which taxpayers may identify or assign rights to claim the credit.
The most significant issue may be demonstrating the permanence of long-term sequestration and the standards by which acceptable storage methods are determined. In this regard, the IRS is seeking comment on whether the existing environmental standards governing underground injection control permits are sufficient to ensure the security of storage. While the IRS guidance is critical to the development of large scale projects, some projects have recently been announced, notwithstanding existing uncertainties regarding eligibility for the credit.
California LCFS Incentives
The LCFS program in California is a regulatory incentive program designed to encourage the use of cleaner, less carbon-intensive vehicle fuels. The California Air Resource Board's ("CARB's") articulated goal for the LCFS program is to reduce the carbon intensity of vehicle fuels used in the state by 20% by 2030, compared to a 2010 baseline. The LCFS program has recently been amended to recognize CCS as a method of reducing the carbon intensity of fuels.
Background on the LCFS Program
. Under the LCFS program, each supplier of vehicle fuels in California
is required to achieve a "benchmark" standard of "carbon intensity" of the fuels it supplies in the state. This standard is represented by grams of CO2
generated by the lifecycle of production and use of the fuels with respect to a specified unit of energy (the unit being the megajoule or "MJ")
when that fuel is used for transportation.
The benchmark carbon intensity for gasoline has been set by CARB at 93.23 gCO2
e/MJ for 2019, and declines to 79.55 gCO2
e/MJ in 2030. Benchmarks have also been established for diesel fuel and jet fuel.
The LCFS program drives reductions in carbon intensity by requiring that fuels supplied by regulated entities in California, on average, meet the benchmark. The regulated entity may do this by producing or importing fuels that meet the benchmark or by buying LCFS credits that represent fuels with a lower carbon intensity than the benchmark. Because conventional fuels have carbon intensity values well above the benchmark, the only options for fuel suppliers to meet the requirements are (1) supplying alternative fuels as a significant percentage of total fuel supplied, or (2) buying LCFS credits.
Credits are generated by using fuels that CARB has approved and to which CARB has assigned a specific carbon intensity value. To assign a carbon intensity, CARB must consider the lifecycle greenhouse gas emissions of the fuel. In making that lifecycle analysis, CARB considers location, technology, inputs and energy content, among other factors. As a result, ethanol produced in Iowa may have a different carbon intensity than ethanol produced in Brazil. Each approved fuel that is assigned a carbon intensity value is described as a "pathway." Fuels with a carbon intensity value below the benchmark generate LCFS credits equal to the number of metric tons of CO2
e below the benchmark attributable to the fuel.
According to data compiled and published by CARB, the LCFS credits have significant value. In calendar years 2016, 2017 and 2018, the average prices of LCFS credit transactions reported by CARB were, respectively, $101, $89 and $160 per credit, based on significant volumes of reported purchases of such credits (5 million to 13 million credit transfers per year). Thus far, in 2019, the average prices were $190 (January), $186 (February), $188 (March) and $180 (April) per credit on monthly volumes ranging from 548,000 credits to approximately 1.7 million credits.
CCS within the LCFS Program
. In January 2019, CARB added CCS to the LCFS program. Because CCS is new to the LCFS program, no projects have been approved yet, but CARB is reviewing applications to add "pathways" related to CCS and to approve specific projects for LCFS credit generation. It is now possible to generate LCFS credits related to CCS projects that directly capture CO2
from the air, as well as CCS projects associated with the delivery of fuels in California. Eligible projects must sequester CO2
onshore, in saline or depleted soil and gas reservoirs, or oil and gas reservoirs in connection with enhanced oil recovery, provided that the projects meet the requirements for permanence.
CARB notes four avenues for generating LCFS credits using CCS projects: (1) use of CCS when calculating a low carbon fuel pathway (e.g.
, ethanol or biodiesel) for a carbon intensity, (2) refinery investment program (e.g., steam methane reforming), (3) innovative crude (e.g., cogeneration at oilfield) or (4) direct air capture.
Fuel pathways under the LCFS program calculate carbon intensity based on the lifecycle emissions of fuel production, so reductions of CO2
emissions associated with the production of fuels achieved through CCS should result in a lower carbon intensity of a particular fuel.
Refineries may be eligible to receive LCFS credits for greenhouse gas reductions using CCS based on the fuel volumes sold, supplied or offered for sale in California. Similarly, credits may be generated for crude oil that has been produced or transported using CCS and delivered to California refineries for processing. Direct air capture and sequestration facilities located outside of California are eligible to generate LCFS credits using CCS. CCS projects employed in connection with refineries, crude oil projects and fuel production are eligible for credits based only upon volumes of fuel delivered in California.
Challenges to Implementation
There are several elements of the Section 45Q tax credit and the LCFS program that present legal and practical challenges to successful use of the incentives they provide. These include the requirement for permanent, or at least secure, sequestration.
If sequestration of CO2
is going to be useful in mitigating overall greenhouse gas emissions, the gas that is sequestered must remain where it is stored. While there are storage caverns and geological formations into which CO2
can be injected, there is a significant technical challenge of ensuring that injected CO2
(which is under high pressure) remains where it is placed.
- Permanence. Under the LCFS program, CARB requires a demonstration that the geologic conditions are nearly certain to ensure that all injected CO2 (for which credits are obtained) remains stored securely for 100 years and requires monitoring and maintenance to demonstrate that such storage is effective for 50 years.
- Storage Security. The IRS is considering the same issue, but from a different perspective. In its Notice, 2019-32, the IRS requests comments on whether satisfaction of existing underground injection control ("UIC") requirements would be sufficient to demonstrate the "security" of the storage. These requirements are imposed by the U.S. Environmental Protection Agency through the issuance of permits for underground injection of liquids or gases. Compared with the LCFS program requirements for permanence, compliance with the UIC program could establish a less stringent standard for demonstrating the security of storage. The IRS Notice requests comments on whether the UIC standards are sufficient, or whether another standard should be imposed. If there are discrepancies between the storage security standard for the Section 45Q tax credit and the LCFS program, CCS projects that qualify for the Section 45Q tax credit may not qualify under the LCFS program.
Tax credits may not be valuable to project companies that own or operate CCS projects and do not have significant income. However, Section 45Q credits could be used to attract tax equity investments similar to those used in the renewable electricity sector, where transactions are designed to allow monetization of the production tax credit and/or investment tax credit using partnership structures. The opportunities for such transaction structuring are enhanced by the ability of those implementing CCS technologies to transfer rights to the Section 45Q tax credits. Similarly, an owner or operator of a CCS project may contractually delegate the right to generate credits under the LCFS program. These two programs may provide new opportunities for investment.
There is some question as to the economic sectors in which these incentives are likely to have the largest impact. Though fossil-fired power generation emits substantial amounts of CO2
, even with the Section 45Q incentives investments in CCS technologies may be prohibitively expensive in mitigating CO2
emissions from power plants, given currently available technologies. 
Further, while it is theoretically possible for CCS associated with fossil-fired power generation to qualify for LCFS program credits, no such pathway has been approved by CARB.
A more promising area for development of successful CCS projects is in connection with vehicle fuel supply into California, whether at refineries, or in connection with alternate fuel pathways. Ethanol plants, among other types of alternative fuels, generate significant CO2
. CCS that is incorporated into lifecycle of alternative fuel production would reduce the carbon intensity of the alternative fuel. Such reductions should generate a larger number of LCFS credits for the same amount of alternative fuel produced without CCS. And such projects should also qualify for the Section 45Q tax credit. The combined benefits may be very valuable to developers who have a connection with the fuel supply system in California.
Only the first 75 million metric tons of carbon captured by taxpayers were eligible for the original Section 45Q tax credit, granted on a first-come, first-served basis.
The BBA modified the credits for then-existing facilities, increased credit values and expanded the applicability of credits in various important ways. This client update is focused on new facilities (constructed on or after February 9, 2018) and on facilities that sequester or use COx
, so some of the details of the legislation and related guidance are not discussed in this update.
That credits are available for 12 years contrasts with the 10-year period available for the production credit under Section 45 for investment in renewable electricity projects.
This update focuses on sequestration of COx
, but the "utilization" of COx
is also eligible for the credit. "Utilization" for purposes of the credit includes (i) the fixation of COx
through photosynthesis or chemosynthesis, such as through growing of algae or bacteria, (ii) the chemical conversion of qualified COx
to a material or chemical compound in which COx
is securely stored, or (iii) the use of such COx
for any other purpose for which a commercial market exists (other than enhanced oil or natural gas recovery) approved by the IRS. The credit also includes the use of the captured COx
as a tertiary injectant in certain enhanced oil or natural gas recovery projects that are disposed of by the taxpayer in secure geological storage.
Approximately $17.76 per metric ton in 2019.
In addition to Section 45Q, a federal tax credit, certain enhanced oil and gas recovery projects in Texas may qualify for additional state tax incentives. Texas allows up to a 50% reduction from the state severance tax for oil recovered using CO2
that is (1) man-made, (2) would otherwise be released into the atmosphere as industrial emissions, (3) is measurable at the source of capture, and (4) is sequestered using one or more geological formations in Texas following the enhanced oil recovery process. The requirements governing this program are similar to those found in Section 45Q for enhanced oil and gas recovery projects.
Approximately $28.74/MT in 2019.
45 days after May 20, 2019, the date that IRS Notice 2019-32 was published.
One of the more interesting features of the expanded Section 45Q tax credit is that it may be transferred from the owner of the equipment to other parties involved in the sequestration process, such as the party that disposes of the COx
or utilizes the COx
Oxy Low Carbon Venture Press Release dated May 21, 2019 (available at https://menafn.com/1098553360/Oxy-Low-Carbon-Ventures-and-Carbon-Engineering-begin-engineering-worlds-largest-Direct-Air-Capture-plant?src=Rss
) (describing the development of a direct air capture facility in the Permian Basin).
The LCFS program regulates vehicle fuels imported into California and produced in California, with some lack of clarity regarding "production." A producer is an entity that "made or prepared" the fuel. Each such entity is a regulated entity under the LCFS program.
The measure of a carbon equivalent is used to account for different global warming potentials, per ton, of other types of greenhouse gases that may be covered by the program and associated with fuels (e.g., nitrous oxide and methane).
A MJ is a metric unit of energy equivalent to approximately 948 British thermal units. There are approximately 132 MJ in one gallon of gasoline.
The actual measurements are in MTs of CO2
e per MJ.
 See https://www.arb.ca.gov/fuels/lcfs/credit/lrtmonthlycreditreports.htm
 See https://www.arb.ca.gov/fuels/lcfs/background/basics.htm
, slide 30. If CO2
derived from direct air capture is converted to fuels, the project would need to apply for a fuel pathway certification as opposed to obtaining credits for the project itself. See
17 CCR §95490(a)(2).
Air Resources Board's Carbon Capture and Sequestration Program: 2016 Progress and Future Plans (available at https://www.arb.ca.gov/cc/ccs/documents/CCS_Summary_Paper_April_2017.pdf
) (costs of implementing CCS at power plants).